Understanding Financial Jargon
By The MBO Group | December 18, 2013
As many of our clients are operating managers who have not been through a management buyout, we find it helpful to provide an explanation of the many financial terms used in the process.
Amounts owed, usually restricted to amounts due from the sale of goods and services. Accounts payable is a current liability with a normal credit balance.
Accounts payable days
Measures the average number of days in which a company pays its vendors.
Amounts due, usually restricted to amounts due from the sale of goods and services. Accounts receivable is a current asset with a normal credit balance.
Accounts receivable days
Measures the effectiveness of the company's credit policies and indicates the level of investment in receivables needed to maintain the company's level of sales.
The total depreciation recognized and recorded for an asset since its acquisition. Accumulated depreciation has a normal credit balance and is a contra asset. It is subtracted from the asset's original cost to determine net asset value.
The interest due on a debt obligation since the last interest payment was made.
The purchase of one company by another business entity.
Adjusted book value
The book value that results after one or more asset or liability amounts are added, deleted, or changed from the respective book amounts.
A group of external advisors to a private company. Advice provided varies from overall strategy to financing and acquisition assessments. It is less formal than a Board of Directors.
Capital that is raised for a private company from independently wealthy investors. This capital is generally used as seed financing.
The systematic reduction or writing off of an item over a specific number of time periods.
The purchase of some or all of a company's assets, as opposed to buying the company itself.
Any possession that has cash or exchange value. Collectively, the assets of a person or business are the means that may be used to offset liabilities. In accounting, the assets are all of the entries on a balance sheet showing the entire resources of the person or business, which when compared with liabilities, becomes a disclosure of net worth.
A loan, typically from a commercial bank, that is backed by asset collateral often belonging to the entrepreneurial firm or the entrepreneur.
A procedure in which a firm can sell its accounts receivable invoices to an asset based lender, which pays a percentage of the invoices immediately and the remainder (minus a service fee) when the accounts receivable are actually paid off by the firm's customers. Also known as Factoring. Also refers to a type of bank operating line of credit that typically provides more credit than traditional banks but require more monitoring.
Measures the company's overall investment. Asset turnover is calculated by dividing sales by total assets.
A financial statement that indicates what assets a company owns and how those assets are financed in the form of liabilities or ownership interests, at a specific date.
The year from which comparisons and/or forecasts are made. If the current year is used, management projects year-end results.
An offer made directly to the Board of Directors of a target company. Usually made to increase the pressure on the target with the threat that a tender offer may follow.
This is a combination of a Management Buyout (MBO) and buy-in (MBI) where the management team buying the business includes both existing management and new managers.
A debt issued for a period of more than a year.
The amount at which an item is carried in accounting records and reported in financial statements. A fixed asset's book value is its original cost less accumulated depreciation.
Means of financing a small firm by employing highly creative ways of using and acquiring resources without raising equity from traditional sources or borrowing money from the bank. MBOs were originally called bootstrapped deals.
The level of revenues and expenses at which a project would make zero profit.
A common fee used in takeover agreements if the seller backs out of a deal to sell to the purchaser. A breakup fee, or termination fee, is required to compensate the prospective purchaser for the time and resources used to facilitate the deal. Breakup fees are normally 1-3% of the deal's value.
A limited amount of equity or short-term debt financing typically raised for a period of 6-18 months and is meant to "bridge" a company to the next round of financing.
Burn out / Cram down
Extraordinary dilution, by reason of a round of financing, of a non-participating investor's percentage ownership in the issuer.
The rate at which a company expends net cash over a certain period, usually a month.
The process of arriving at an opinion or determination of the value of a business enterprise.
Compound Annual Growth Rate. The year over year growth rate.
Sources of long-term financing available to the company from shareholders.
The total value of the assets being used in the business to make money. Usually calculated as total assets less current liabilities.
The difference between an asset's purchase price and selling price, when the selling price is greater. Long-term capital gains (on assets held for a year or longer) are taxed at a lower rate than ordinary income.
To record an outlay as an asset (as opposed to an expense), which is subject to depreciation or amortization.
Also called a Spin-off. This is when entire divisions or parts of them are spun off from a larger holding into an independent company and often sold to its management team (Management Buyout).
Cash flow statement
A summary of the company's cash flow over a period of time.
The amount of cash available to a company at a given point in time.
An investment event occurring after the required legal documents are implemented between the investor and a company and after the capital is transferred in exchange for company ownership or debt obligation.
Co-sale provisions or rights
Allows investors to sell their shares of stock in the same proportions and for the same terms as the founders, managers, or other investors, should any of those parties receive an offer.
Also called a Rollup, this is an investment strategy in which a firm acquires a series of companies in the same or complementary fields, with the goal of becoming a dominant regional or nationwide player in that industry. In some cases, a holding company will be created to acquire the new companies. In other cases, an initial acquisition may serve as the platform through which the other acquisitions will be made.
The additional value inherent in the control interest as contrasted to a minority interest, which reflects its power to control.
The number of shares of stock into which a convertible security may be converted. The conversion ration equals the par value of the convertible security divided by the conversion price.
Rights by which preferred stock "converts" into common stock. Conversion rights may carry with them anti-dilution protections.
Cost of goods sold (COGS)
The cost specifically associated with units sold.
A protective clause in an agreement – an undertaking to perform in a certain manner. A Financial Covenant is an undertaking or a requirement to maintain a financial ratio associated with loans or debentures.
An asset on the balance sheet which can either be converted to cash or used to pay current liabilities within 12 months. Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, inventory and the portion of prepaid liabilities which will be paid within a year.
An obligation of the business that is to be settled in cash within 12 months.
Current assets divided by current liabilities, an indication of a company's ability to meet its short term obligations.
An agreement made between investors and lenders, and the company, defining the rights and obligations of the parties involved. The process by which one arrives at the final term and conditions of the investment.
Debt divided by shareholder's equity, showing the relationship between funds provided by creditors and funds provided by shareholders; a high ratio indicates high risk and a low ratio indicates low risk. Mezzanine / Subordinated Debt is classified as equity for this calculation provided that all lenders to the company have entered into an Intercreditor / Subordination Agreement.
An expense recorded to reduce the value of a long-term tangible asset. Since it is a non-cash expense, it increases free cash flow while decreasing the amount of a company's reported earnings.
A reduction in the percentage ownership of a given shareholder in a company caused by the issuance of new shares.
Person elected by shareholders to serve on the Board of Directors. The directors appoint the president, vice president and all other operating officers, and decide when dividends should be paid (among other matters).
Discounted cash flow (DCF)
This is a method of valuing a project, company or asset using the concept of the time value of money. The future cash flows are estimated and discounted to give their present values (PVs). The sum of all future cash flows, both incoming and outgoing, is called the net present value (NPV), which is taken as the value or price of the cash flows in question. The model can be also be used to calculate the discount rate or yield.
These may include methods used in private companies to minimize tax and increase personal or family benefits. The discretionary items can include bonuses or distributions.
Corporate bonds of companies that have either filed for bankruptcy or appear likely to do so in the near future.
Disbursement of cash to the company's shareholders.
The process of spreading investments among various different types of securities and various companies in different fields.
An investigation process undertaken by potential investors, lenders and purchasers of the business to analyze and assess the desirability, value, and potential of the investment opportunity.
A deal structure element used by the buyer to reduce the upfront cash payment for the business.
"Earnings Before Interest, Taxes, Depreciation and Amortization." A measure of cash flow calculated as: Revenue - Expenses (excluding tax, interest, depreciation and amortization). EBITDA looks at the cash flow of a company available to cover loan payments, CAPEX, interest and taxes. This is a critical number often used in valuing a company (normally expressed as a "multiple" of EBITDA).
Economies of scale
The decrease in average production costs accompanying an increase in capital employed.
Employee Stock Option Plan
Referred to as an ESOP. A plan established by a company whereby a certain number of shares are reserved for purchase and issuance to key employees. Such shares usually vest over a certain period of time to serve as an incentive for employees to build long-term value for the company.
This represents the aggregate value of a company including debt and equity.
Ownership interest in a company, usually in the form of stock or stock options.
A clause present in deal documentation that reserves a percentage or fixed amount of preferred proceeds for a particular holder. The carve-out can be assigned any seniority and thus any position within the preference distribution stack.
A method of enhancing an investor's return. Typically associated with Mezzanine Financings where a small number of shares or warrants are added to what is primarily a debt financing.
The price at which an option or warrant can be exercised.
An investor's intended method for liquidating their holdings while achieving the maximum possible return. These strategies depend on the exit climates including market conditions and industry trends. Exit strategies can include an initial public offering (IPO), a sale of the company, or a recapitalization.
Fair market value
The amount at which property would change hands between a willing seller and a willing both parties have a reasonable knowledge of the relevant facts and neither one is acting under compulsion.
A person who helps to arrange a transaction.
First refusal rights
A negotiated obligation of the company or existing investors to offer shares to the company or other existing investors at fair market value or a previously negotiated price, prior to selling shares to new investors.
Costs that remain relatively constant regardless of the volume of operations of the business. Common examples include: rent, depreciation, property taxes and executive salaries.
Companies often require several rounds of funding. If a private equity firm has invested in a particular company in the past, and then provides additional funding at a later stage, this is known as 'follow-on funding'.
Redemption of convertible debt, convertible preferred stock, or common stock on pre-specified terms in situations where the company's value has not appreciated according to the agreed upon plan.
Free cash flow
The cash flow of a company available to service the capital structure of the firm. Typically measured as operating cash flow less capital expenditures and tax obligations.
Fully diluted outstanding shares
The number of shares representing total company ownership, including common shares and current conversion or exercised value of the preferred shares, options, warrants, and other convertible securities.
The indicated area of specialization of a venture capital fund usually expressed as Balanced, Seed and Early Stage, Later Stage, Mezzanine or Leveraged Buyout (LBO).
Specialist advisors who assist institutional investors in their private equity allocation decisions. Institutional investors with little experience of the asset class or those with limited resources often use them to help manage their private equity allocation.
The intangible asset that arises as a result of name, reputation, client patronage, location, products and similar factors not separately identified and/or valued but which generate economic benefits.
Employment contract of upper management that provides a large payout upon the occurrence of certain control transactions, such as a certain percentage share purchase by an outside entity or when there is a tender offer for a certain percentage of a company's shares.
Gross profit margin
The excess of revenue over cost of goods sold. Gross profit on an individual sale is equal to the selling prices minus the costs of acquiring and preparing the goods for sale, but before deducting the selling or administration expenses.
Reaping the benefits of investment in a privately held company by selling the company for cash or stock in a publicly held company; also known as an "exit strategy".
Hockey stick projections
The general shape and form of a chart showing revenue, customers, cash, or some other financial or operational measure that increases dramatically at some point in the future. Managers are tempted to develop business plans with hockey stick charts to impress potential investors, which should be avoided.
A detailed description of the business which is given to prospective investors and buyers after execution of a confidentiality agreement.
A venture's legally protectable intangible assets. The major forms of intellectual property are utility patents, design patents, plant patents, copyrights, mask works, trade names, domain names, rights of personality, trade secrets, and trademarks.
This is an agreement among creditors that sets forth the various lien positions and the rights and liabilities of each creditor and its impact on the other creditors. The intercreditor agreement is usually the most fiercely negotiated document in the loan agreements.
Internal rate of return (IRR)
A typical measure of how a private equity investor measures performance. IRR is technically a discount rate: the rate at which the present value of a series of investments is equal to the present value of the returns on those investments.
Provides an indication of the efficiency of the business in using inventory. The higher the ratio, the faster the inventory is moving through the business.
Professional management attracted by the founder to run the company. Key employees are typically retained with warrants and ownership of the company.
Letter of intent (LOI)
This is a document outlining an agreement between two or more parties before the agreement is finalized. The concept is similar to the so-called heads of agreement. The final agreements can include Asset Purchase Agreements, Share Purchase Agreements, Joint-Venture Agreements, and other similar agreements which aim at closing a management buyout.
Leveraged buyout (LBO)
A takeover of a company, using a combination of equity and borrowed funds. Generally, the target company's assets act as the collateral for the loans taken out by the acquiring group.
Management buyout (MBO):
This is when the management of a division of a public company (known as a Carve Out) or of a private company (often triggered by the owner's succession issues) come together to purchase their business unit. This is one of the least risky types of private equity investment because the company is already established and the managers running it know the business - and the market it operates in - extremely well. It is increasingly becoming the method of choice for private company founders to obtain liquidity.
Management buy-in (MBI)
Occurs when a manager or a management team from outside the company raises the necessary finance, buys it, and becomes the company's new management.
Combination of two or more corporations in which greater efficiency is supposed to be achieved by the elimination of duplicate plant, equipment, and staff, and the reallocation of capital assets to increase sales and profits in the enlarged company.
Also referred to as Subordinated Debt. Debt with inferior liquidation privileges to senior debt in case of a bankruptcy; it carries higher interest rates than senior debt, to which it is subordinated, to compensate for the added risk, and will sometimes have attached warrant Kickers.
Non-disclosure agreement. An agreement issued by entrepreneurs to potential investors to protect the privacy of their ideas when disclosing those ideas to third-parties.
The net earnings of a corporation after deducting all costs of selling, depreciation, interest expense and taxes.
Net present value
An approach used in capital budgeting where the present value of cash inflow is subtracted from the present value of cash outflows. NPV compares the value of a dollar today versus the value of that same dollar in the future after taking inflation and return into account.
The typical label for any newly organized company, particularly in the context of a leveraged buyout.
No shop, No solicitation clauses
Also known as an exclusivity clause. Requires the company to negotiate exclusively with the investor, and not solicit an investment proposal from anyone else for a set period of time after the term sheet is signed. The key provision is the length of time set for the exclusivity period.
An agreement often signed by employees and management whereby they agree not to work for competitor's companies or form a new competitor company within a certain time period after termination of employment.
Also referred to as recasting. EBITDA as determined from the financial statements recalculated to reflect its operations as they would have been on a standalone basis (removing owners' unusually high compensation to be consistent with industry averages, allocated corporate overhead charges, and one-time non-recurring events). This is used to reflect the standalone entity's cash flow performance.
A shareholder's right to acquire an amount of shares in a future offering at current prices per share paid by new investors, whereby his/her percentage ownership remains the same as before the offering.
Shares of a firm that encompass preferential rights over ordinary common shares, such as the first right to dividends and any capital payments.
A class of capital stock that may pay dividends at a specified rate and that has priority over common stock in the payment of dividends and the liquidation of assets. Many private equity firms use preferred stock as their investment vehicle.
Investors, usually represented by pools of capital called funds, or individual investors who invest typically in private company, seeking equity return for their investment. Used to help finance Management Buyouts.
The reorganization of a company's capital structure. A company may seek to save on taxes by replacing preferred stock with loans in order to gain interest deductibility. Recapitalization can be an alternative exit strategy for venture capitalists and leveraged buyout sponsors. (See Exit Strategy and Leveraged Buyout)
Reps and warranties
These are statements by which one party gives certain assurances to the other, and on which the other party may rely. In this context, a representation is commonly a declaration of a specific fact that can be verified to be true or not and a warranty may be more of an assurance. Often there are specific remedies or consequences specified if the representations and warranties are not accurate or are not fulfilled. In an MBO, these are typically less than with a sale to a third party.
Accumulated net profits kept in the business after dividends are paid.
Return on investment (ROI)
The amount earned per year on an investment, usually expressed as a percentage.
Right of first refusal
The right of first refusal gives the holder the right to meet any other offer before the proposed contract is accepted.
The chance of loss on an investment due to many factors including inflation, interest rates, default, political upheavals, and foreign exchange.
In certain circumstances the management and seller of the company or business unit agree to a deal whereby the seller agrees to finance the sale of the company, accepting extended payment terms or a debenture for the value of the purchase price.
A corporation with no assets and no business.
A division or subsidiary of a company that becomes an independent business. Typically, private equity investors will provide the necessary capital to allow the division to "spin out" on its own; the parent company may retain a minority stake. A viable candidate for a Management Buyout.
The sum required by a lender to provide a standby commitment normally has a standby fee, which is forfeited should the loan not be closed within a specified time.
The right to purchase or sell a stock at a specified price within a stated period.
The purchase of an operating business that is in the same industry or complements the buyer's current business.
Corporate or individual investors that add value to investments they make through industry and personal ties that can assist companies in raising additional capital as well as provide assistance in the marketing and sales process.
As opposed to a Management Buyout. A purchaser, normally from within the seller's industry, who, independent from the existing management team, makes a bid for the company. Strategic Buyers often look to operating synergies between the two companies as an attractive feature of the acquisition.
Also known as Mezzanine Debt. Debt with inferior liquidation privileges to senior debt in case of a bankruptcy; sub debt will carry higher interest rates than senior debt, to which it is subordinated, to compensate for the added risk; will typically have attached warrants or equity conversion features.
Ownership of shares in a company resulting from work rather than investment of capital--usually managers receive "sweat equity" as part of a Management Buyout from the Private Equity investor.
The opportunity for two or more businesses working together to produce a result not obtainable by any of the agents independently.
Tag-along rights / Rights of co-sale
A minority shareholder protection affording the right to include their shares in any sale of control and at the offered price.
An offer made directly to shareholders to purchase stock. One of the more common ways hostile takeovers are implemented.
A document from a potential investor or bank that outlines the terms and conditions of a potential offer, subject to due diligence and subsequent approval by the investor or bank.
The value of a company at the end of a given time period.
Time value of money
The basic principle that money can earn interest, therefore something that is worth $1 today will be worth more in the future if invested. This is also referred to as future value.
Stock issued by a company but later reacquired. It may be held in the company's treasury indefinitely, reissued to the public, or retired. Treasury stock receives no dividends and does not carry voting power while held by the company.
The Toronto Stock Exchange; previously known as TSE
Vendor Take Back (VTB)
In certain circumstances the management and seller of the company or business unit agree to a deal whereby the seller agrees to "take back" a note as a method of paying part of the sellers overall purchase price.
The common stockholders' right to vote in the affairs of the company. Preferred stock usually has the right to vote when preferred dividends are in default for a specified amount of time.
A type of security that entitles the holder to buy a proportionate amount of common stock or preferred stock at a specified price for a period of years. Warrants are usually issued together with a loan, a bond or preferred stock --and act as sweeteners, to enhance the marketability of the accompanying securities.
Weighted average cost of capital (WACC)
The computed cost of capital. Determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure, and then totaling the result.
The excess of current assets over current liabilities, also called net working capital.
A negotiated agreement between the debtors and its creditors outside the bankruptcy process.
The act of changing the value of an asset to an expense or a loss. A write-off is used to reduce or eliminate the value an asset and reduce profits.
An upward or downward adjustment of the value of an asset for accounting and reporting purposes. These adjustments are estimates and tend to be subjective; although they are usually based on events affecting the transaction under review.
In Their Words
When I heard The MBO Group had done such a great job helping one of my key suppliers arrange for the managers to buy their business from the US parent – I asked The MBO Group to help me find and buy businesses as part of my expansion. Within 8 months we completed two transactions and another one 4 months later. [read full testimonial]
President, The IDP Group